Deck 2: The Risk of Fraud and Mechanisms to Address Fraud: Regulation,corporate Governance,and Audit Quality

Question 1

Management compensation that is tied to profits may create incentives to commit fraud.

Answer 1

True

Question 2

Professional skepticism is required on audit engagements that have a high risk of fraud but can be disregarded for all other engagements.

Answer 2

False

Question 3

The onslaught of fraud in financial statements over the recent decade has been the first of its kind in history.

Answer 3

False

Question 4

Once the fraud assessment is complete in the planning stage,the auditor need not consider fraud further.

Question 5

Fraud detection procedures should only be performed for clients that have had fraud problems in the past.

Question 6

An example of fraudulent financial reporting is the treasurer's diversion of hundreds of thousands of dollars into a personal money market account.

Question 7

Fraud is an intentional act involving the use of deception that results in a material misstatement of the financial statements.

Question 8

The fraud triangle requires the auditor to actively consider and assess the risk of fraud for clients and their financial statements.

Question 9

According to professional audit standards,the audit team should assemble early in the planning stages of an audit to conduct a fraud "brainstorming" session in order to determine the types of fraud that may occur with the client.

Question 10

If an auditor discovers evidence of fraud,the planned audit procedures should be adjusted accordingly.

Question 11

An example of fraudulent financial reporting is the CFO intentionally overstating sales to boost profits.

Question 12

Consideration of fraud in financial statement audits is a relatively new concept derived originally from the Sarbanes-Oxley Act.

Question 13

The auditor is not responsible for the presentation of financial statements; therefore,the auditor has no responsibility for fraud in the financial statements.

Question 14

Internal controls are implemented in order to give perpetrators the impression that the risk of being caught is low.

Question 15

Auditors need to consider fraud arising from misappropriation of assets and fraudulent financial reporting.

Question 16

The auditor is responsible for actively considering fraud risks in order to obtain reasonable assurance that the financial statements are free of material fraud.

Question 17

The most important lesson to be learned from The Great Salad Oil Swindle is that auditors can commit fraud by falsely including inventory that does not exist.

Question 18

Management may feel pressure to maintain debt covenants,which is a deterrent to fraud.

Question 19

According to professional audit standards,the audit team should assemble early in the planning stages of an audit to conduct a fraud "brainstorming" meeting in order to determine the types of fraud that may occur with the client.

Question 20

Pressure upon management to manipulate financial information is a common characteristic in fraud cases.

Question 21

During the time period of 1998 to 2007,the median size of public company perpetrating fraud rose tenfold to $100 million (as compared to the previous ten years).

Question 22

Material fraud perpetrated by management must always be reported by the auditor to the SEC.

Question 23

Rationalization involves the mindset of the fraudster to justify committing the fraud.

Question 24

Auditors are responsible to fraud even if it has an immaterial effect on the financial statements.

Question 25

The auditor should not consider that fraud is present in revenue accounts because the auditor must remain objective.

Question 26

One fraud risk factor includes the presence of domineering members of management who seek the ultimate loyalty of subordinates.

Question 27

Successful corporate governance depends upon successful management of the company,as management has the primary responsibility for creating a culture of performance with integrity and ethical behavior.

Question 28

When fraud risk is great in the organization under audit,procedures applied are likely to be more extensive.

Question 29

Complex transactions such as derivative instruments provide management certain opportunities to manipulate financial statements to its advantage.

Question 30

A board of directors that is actively involved in monitoring management mitigates opportunities to commit fraud.

Question 31

Auditors must keep a questioning mind when analyzing management responses to inquiry and auditors should strive to obtain corroborating evidence before accepting the management responses.

Question 32

Various types of ways that fraud could be perpetrated should be hypothesized by the auditor prior to conducting audit testing.

Question 33

The auditor must perform a brainstorming session with client management in order to plan the procedures to be performed.

Question 34

The audit team should develop its own ideas about how fraud may be performed by the client and then covered up.

Question 35

Audit tests do not relate to fraud testing because testing for fraud is conducted in a separate engagement.

Question 36

According to COSO studies,the majority of the frauds took place at companies that were listed on the Over-The-Counter (OTC)market,rather than those listed on the NYSE or NASDAQ.

Question 37

According to the PCAOB,the detection of material fraud is a reasonable expectation of users of audited financial statements.

Question 38

When the risk of fraud is high in financial statements,the auditor should assign less experienced auditors to the engagement.

Question 39

Management always uses journal entries to commit fraud because they are not reviewed by auditors.

Question 40

The landmark Enron fraud in the early 2000's involved the movement of significant debt off the books to related,unconsolidated entities.

Question 41

Auditors are required to inform the audit committee of any significant audit adjustments discovered during the engagement.

Question 42

Managers of organizations are hired by Boards of Directors to perform responsibilities such as the implementation of internal control.

Question 43

An audit must be performed by persons who can make sound judgments relating to complex accounting issues.

Question 44

The auditor must communicate significant audit adjustments to the audit committee.

Question 45

Corporate governance is a process by which the owners,but not the creditors,exert control and require accountability for the resources entrusted to the organization.

Question 46

The auditor can be satisfied with less than persuasive evidence in the audit process because of the belief that management is honest.

Question 47

The audit committee is a subcommittee of the board of directors comprised of independent outside directors.

Question 48

When preliminary fraud risk is high the auditor should pay close attention to areas of the audit that are highly subjective and should increase the predictability of the audit procedures.

Question 49

Professional skepticism involves such things as questioning and corroborating management responses to inquiries and determining the authenticity of documents.

Question 50

Any major disagreement the auditor has with management should be discussed with the audit committee.

Question 51

Transparency is a desirable,but not critical,element of effective corporate governance.

Question 52

Management of companies should have the ability to hire and fire the external auditor.

Question 53

Which of the following statements about fraud is true?

A)Unless auditors can provide assurance that the financial statements are free of material misstatements due to fraud,there is no justification for the audit function.
B)The AICPA has mandated that the auditor take on more responsibility than previously required because of management's demand for fraud detection.
C)It is the responsibility of the auditor to provide internal control over a client organization sufficient to discover or prevent fraud from occurring.
D)Auditor-initiated fraud is a large concern of shareholders and the audit committee must continually monitor the auditors to ensure they are not misstating financial statements.

Question 54

The audit committee should have the authority to hire and fire the external auditor.

Question 55

Audit committees of publicly traded companies must establish whistleblowing mechanisms within the company.

Question 56

Why is fraud detection an important part of the audit?

A)Auditors are required to seek out and find all fraud,regardless of its magnitude.
B)Auditors expect that management will make them aware of any fraud in the financial statements.
C)Society expects that financial statements have not been materially misstated due to fraud.
D)Society realizes that some fraud was not intended to be discovered by auditors.

Question 57

Which of the following represents the size of company that has historically committed fraudulent financial reporting or that has experienced asset misappropriation by its employees?

A)Large corporations.
B)Middle-market corporations.
C)Small and start-up companies.
D)All companies.

Question 58

The auditor has a responsibility to design the audit to provide absolute assurance of detecting material fraud.

Question 59

The audit committee must be composed of outsiders such as the organization's attorney and audit partner.

Question 60

The objective of financial reporting is to provide useful information to interested users.

Question 61

What type of fraud occurs when the deposits of current investors are used to pay returns on the deposits of previous investors with no real investment happening?

A)Skimming.
B)Ponzi Scheme
C)Channel Stuffing.
D)Payroll Fraud.

Question 62

According to professional audit standards,how might an understanding of the nature of fraud that may occur in the client organization be identified by an audit firm?

A)Fraud training courses from actual corporate fraud ex-criminals.
B)Conducting a brainstorming session with the members of the audit team.
C)Circulating a survey to the client company employees for completion.
D)Discussions with other audit firms.

Question 63

What is the primary determinate in the difference between fraud and errors in financial statement reporting?

A)The materiality of the misstatement.
B)The intent to deceive.
C)The level of management involved.
D)The type of transaction affected.

Question 64

Which of the following best represents an example of fraud utilizing the lapping technique?

A)An employee transfers cash on the last day of the year in order to double record it in the bank accounts.
B)An employee creates a fictional vendor and requests payment to a personal P.O.box.
C)An employee opens the mail to cover up payroll fraud received on a fictional person.
D)An employee covers up the stealing of receipts by posting to the wrong customer accounts.

Question 65

How must an auditor address fraud in the planning stage?

A)The auditor must test for fraud in the planning stage by sampling accounts.
B)The auditor must consider the likelihood of fraud existing in the company in the planning stage.
C)The auditor must realize that most people are honest and not automatically assume that fraud exists when planning the audit.
D)The auditor must not be aggressive in its initial approach to fraud as trust may be lost by the client.

Question 66

Which of the following statements reflects an auditor's responsibility for detecting fraud?

A)An auditor is not responsible for discovering fraudulent acts involving employee collusion.
B)The audit should be planned to detect fraud caused by departures from GAAP.
C)An auditor is only responsible for detecting fraudulent financial reporting.
D)An auditor should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

Question 67

Which of the following situations represents a risk factor that relates to misstatements arising from misappropriation of assets?

A)A high turnover of senior management.
B)A lack of independent checks.
C)A strained relationship between management and the predecessor auditor.
D)An inability to generate cash flow from operations.

Question 68

Which of the following best represents fraudulent financial reporting?

A)The transfer agent issues 40,000 shares of the company's stock to a friend without authorization by the board of directors.
B)The controller of the company decreases warranty expense by $3 million because the company will otherwise miss analysts' expectations this quarter.
C)The in-house attorney receives payments from the French government for negotiating the development of a new plant in Paris.
D)The accounts receivable clerk covers up the theft of cash receipts by writing off older receivables without authorization.

Question 69

Which is not an example of the theft of accounts receivable?

A)Recording discounts to customers,stealing the cash,and then reducing accounts receivable for the amount of cash stolen.
B)Creating fictional invoices and customers and recording accounts receivable.
C)Writing off accounts receivable as uncollectible to hide receipts taken.
D)Posting upcoming payments to the account of a customer whose most recent payment was diverted.

Question 70

Which of the following frauds is most common?

A)Chief financial officer misappropriation of funds.
B)Misapplication of revenue recognition principles.
C)Management's theft of cash held in reserve accounts.
D)Over-recording expenses related to stock options.

Question 71

Who is most often involved in perpetrating fraudulent financial reporting?

A)The auditors and the attorneys.
B)The treasurer and the board of directors.
C)The chief executive and chief financial officers.
D)The shareholders and the chief operating officer.

Question 72

According to professional auditing standards,which of the following best represents a type of fraudulent financial reporting?

A)Management accrues a liability and discloses the possible outcome of a lawsuit prior to settling the matter.
B)Management reclassifies a negative cash balance by increasing cash and also increasing a current liability.
C)Management discloses its failure to meet loan covenants but states that a waiver has been received.
D)Management intentionally excludes a subsidiary from its consolidated results that it controls significantly.

Question 73

The Center for Audit Quality (CAQ)report identifies which of the following ways in which individuals involved in the financial reporting process can mitigate the risk of fraudulent financial reporting?

A)Individuals involved in financial reporting need to acknowledge that there needs to exist a strong,highly ethical tone at the top of an organization that permeates the corporate culture,including an effective fraud risk management program.
B)Individuals involved in financial reporting need to continually exercise professional skepticism.
C)Individuals involved in financial reporting need to remember that strong communication among those involved in the financial reporting process is critical.
D)All of the above.

Question 74

Which of the following is the most common type of fraudulent financial reporting?

A)Capitalizing major overhauls to operating equipment.
B)Deferring service revenue until it is delivered to customers.
C)Including as sales inventory sold with the right to return.
D)Excluding a contingent liability that has been settled.

Question 75

Which of the following best represents actions that may indicate fraud is pervasive throughout the company under audit?

A)The company's management negotiates deals with vendors in such a manner as to pay lower prices.
B)The company's management drives luxury vehicles and takes vacations to exotic places.
C)The company's management takes an overly aggressive approach to revenue recognition.
D)The company's management estimates bad debts using an aged accounts receivables ledger rather than as a percent of sales.

Question 76

Which of the following best describes professional skepticism?

A)An intent to deceive.
B)An attitude of intrusion and obstinacy.
C)A character that does not waver.
D)A questioning mind.

Question 77

The fraud triangle says three conditions are generally present in the client's organization when fraud occurs.Which of the following is not one of those conditions?

A)Incentives.
B)Professional Skepticism.
C)Opportunity.
D)Ability to rationalize fraud.

Question 78

What is the best way an auditor can detect fraud in the financial statements?

A)Use professional skepticism.
B)Understand Generally Accepted Accounting Standards.
C)Brainstorm with the client to find the types of fraud occurring.
D)Actively search for errors in the financial statements.

Question 79

What should an audit team do when it discovers that fraud risk factors are present on an audit engagement?

A)Retract from the client and inform regulatory bodies.
B)Modify procedures to actively search for the existence of fraud.
C)Reduce the amount of evidence required and resort to management inquiry.
D)Turn the audit over to forensic accountants.

Question 80

Which of the following is most likely considered an omission from financial statement reporting?

A)The company no longer discloses a contingency because it was settled previously.
B)The company does not present goodwill because it was impaired currently.
C)The company does not disclose earnings per share because it is privately held.
D)The company does not present a statement of cash flows because of its current net loss.